3 Consumer Financial Stocks With Below-Industry-Average P/Es

Includes: DFS, NNI, SLM
by: Nick Chiu

In this article, three consumer financial stocks with strong ROEs, high net margins, and below-industry-average P/Es will be presented, including SLM Corp (NYSE:SLM), Nelnet (NYSE:NNI), Inc. and Discover Financial Services (NYSE:DFS).

SLM Corp

SLM Corporation, Sallie Mae, is a holding company whose primary business is to originate, service and collect loans it makes to students and/or their parents to finance the cost of their education. The company provides funding, delivery and servicing support for education loans in the U.S. through Federal Family Education Loan & non-federally guaranteed Private Education Loan Program. SLM dropped 0.36% and closed at $19.13 on February 20, 2013. SLM had been trading in the range of $12.85-$19.40 in the past 52 weeks. SLM has a beta of 1.34.

SLM had sold the residual interest in its SLM Student Loan Trust 2007-4 securitization to a third party, removing student loan assets of $3.8B and related liabilities of $3.7B from SLM's balance sheet, as reported by Business Wire on February 13, 2013. On February 15, 2013, Standard & Poor's revised SLM's outlook to negative from stable on worries about the potential for future reductions in cash flows. However, S&P affirmed SLM's BBB-minus rating. According to the report from Reuters, S&P believes the recent sale of residual interests in the SLM Student Loan Trust securitization 2007-4 represents a shift in the company's strategy related to its Federal Family Education Loan Program (FFELP) portfolio. S&P stated, "The negative outlook reflects our belief that SLM could undertake additional similar transactions, which would reduce future cash flows from the company's FFELP portfolio." However, SLM believes the transaction was positive for the company and will continue to work closely with S&P and other ratings agencies so they can better understand SLM's strategy.

There are a few positive factors for SLM:

  • Stronger revenue growth (3-year average) of 19.3 (vs. the industry average of 5.5)
  • Higher operating margin and net margin of 45.3% and 28.5% (vs. the averages of 43.0% and 21.2%)
  • Stronger ROE of 25.2 (vs. the average of 16.7)
  • Lower P/E of 8.8 (vs. the industry average of 20.7)
  • Lower Forward P/E of 8.3 (vs. the S&P 500's average of 14.0)
  • SLM currently offers an annual dividend yield of 3.14%

Nelnet, Inc.

Nelnet, Inc. is an education services company, providing fee-based processing services and education-related products and services in four areas: loan financing, loan servicing, payment processing and enrollment services (education planning). NNI lost 2.23% and closed at $32.51 on February 20, 2013. NNI had been trading in the range of $21.49-$33.50 in the past 52 weeks. NNI has a beta of 1.28.

Fitch Ratings affirmed senior student loan notes at 'AAAsf' and subordinate notes at 'BBB-'issued by Nelnet Student Loan Trust 2006-1 and Nelnet Student Loan Trust 2006-2. As reported,

The Rating Outlook on all senior notes, which is tied to the sovereign rating of the U.S. government, remains Negative, while the Rating Outlook on the subordinate notes remains Stable. Fitch used its 'Global Structured Finance Rating Criteria', and 'Rating U.S. Federal Family Education Loan Program Student Loan ABS' to review the ratings.

NNI is expected to release its Q4, 2012 earnings on February 28, 2013. Analysts are expecting an EPS of $1.13 with revenue of $197.90M for the quarter ending in December, 2012. The Nelnet Board of Directors declared a first-quarter cash dividend on the company's outstanding shares of Class A common stock and Class B common stock of $0.10 per share, payable on March 15, 2013 to the shareholders of record at the close of business on March 1, 2013.

There are a few positive factors for NNI:

  • Higher revenue growth (3-year average) of 13.7 (vs. the industry average of 5.5)
  • Higher net margin of 25.2% (vs. the average of 21.2%)
  • Higher ROE of 17.0 (vs. the industry average of 16.7)
  • Lower P/E of 8.4 (vs. the industry average of 20.7)
  • Lower Forward P/E of 6.8 (vs. S&P 500's average of 14.0)
  • NNI offers an annual dividend yield of 1.23%

Discover Financial Services

Discover Financial Services is a direct banking and payment services company. The company issues proprietary cards, extends card loans to cardholders, and acquires transactions from merchants whenever a cardholder pays with a Discover card. DFS was down 1.52% and closed at $38.93 on February 20, 2013. DFS had been trading in the range of $29.47-$42.08 in the past 52 weeks. DFS has a beta of 1.50.

DFS wrote off less credit-card debt in January, 2013, as reported by FOXBusiness. Discover's net charge-off rate, or percentage of loans considered uncollectible, fell to 2.2% in January after checking in at 2.5% a month earlier. In the year-earlier period, the rate was 2.9%. The falling delinquency rate indicates that Discover customers are increasingly paying bills on time. As reported, "According to Fitch Ratings, U.S. credit card delinquencies tied to securitized loans closed out 2012 at a rate of 1.63%, the lowest level recorded by the firm since it started its Prime Credit Card Index in 1991." The card loans for Discover were $49.9B at the end of January, which had declined from $51.1B in December, 2012 but was higher than $47.2B in January, 2012.

There are a few positive factors for DFS:

  • Higher net margin of 74.1% (vs. the industry average of 21.2%)
  • Stronger ROE of 26.6 (vs. the average of 16.7)
  • Lower Debt/Equity ratio of 2.1 (vs. the average of 3.4)
  • Lower P/E of 8.8 (vs. the industry average of 19.5)
  • Lower Forward P/E of 7.4 (vs. S&P 500's average of 14.0)
  • Strong buyback activities: DFS is the #21 broker analyst pick among those stocks screened by The Online Investor for strong stock buyback activity.

Analysts Calls

On February 8, 2013, Credit Suisse upgraded DFS from Neutral to Outperform. Analysts have an overall Buy rating for DFS with an average target price of $39.10.

In short, while the stocks above have many positive factors with strong fundamentals, including below-industry-average P/Es and higher ROEs, these consumer financial stocks are cyclical stocks, which means the prices of these stocks are affected by ups and downs in the overall economy, rising and falling with the business cycle.

Note: All prices are quoted from the closing of February 20, 2013 and all calculations are before fees and expenses. Investors and traders are recommended to do their own due diligence and research before making any trading/investing decisions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.